August 2013 (132) Tax Planning Considerations for Tier 1 (Investor) Migrants

The UK encourages foreign direct investments by granting high net worth individual investors the right to reside temporarily in its territory. After a qualifying period, the length of which depends on the value of the investment, the individual can obtain indefinite leave to remain (ILR) in the UK. This allows him or her to apply for British citizenship.

The Immigration Rules that regulate the process are extremely complex and subject to frequent and unexpected changes. The Home Office’s explanatory notes are comprehensive; however, it is uncommon to submit a visa application without the help of immigration and financial advisers. What is most surprising is that despite moving to a high-tax country, seeking comprehensive tax advice often comes as an after-thought, when the investments are made and the arrival dates are set. This article highlights the primary tax planning opportunities available to non-domiciled investors at different stages of the UK immigration process for high-value migrants.

There are two pathways that the prospective investor can take — Tier 1 (Investor) and Tier 1 (Entrepreneur) although this article focuses on the planning opportunities for the former. These differ in the size of the investments and the commitments on behalf of the migrant. The Home Office’s website (click here) explains the regimes in detail. In writing the article the author used extracts from the policy guidance available at the website.

The Tier 1 (Investor) category is for high-net-worth individuals who can afford to invest at least £1 million in the UK. The investor does not need a job offer in the UK nor is he or she required to prove a good command of the English language. Broadly, the funds can be own savings or a loan from a UK bank if there is at least £2 million or more in net personal assets. Many investors come from developing economies such as BRICS where British citizenship is a prized possession. Anecdotal evidence suggests a growing number of the Investors being wives of wealthy foreigners; the latter together with the couple’s children being her dependants who are free to visit the UK as they please without any commitments as to the duration of visits or making the investments.

For the sake of completeness, Tier 1 (Entrepreneur) is for non-European migrants who want to invest in the UK by setting up or taking over, and being actively involved in the running of, a UK business or businesses. Broadly, the applicant needs to invest £200,000 in a UK company and comply with a host of other requirements, including speaking English to a certain standard and having enough money to support themselves in the UK. This route is attractive to younger entrepreneurs who might have sufficient savings and are prepared to actively manage the business and create jobs in the UK. With the recent tightening of the rules allowing foreign students to seek work in the UK after finishing their studies, this route has become especially popular with parents willing to help their children to stay in the UK. Both routes allow the migrant to apply for the ILR after the continuous residence period in the UK of five years. This can be reduced to three years for the investor who invests £5 million or the entrepreneur who makes extraordinary progress with developing their business. This can be further reduced to two years for the investor who invests £10 million in the UK. During the continuous residence period, the migrant cannot be outside the UK for more than 180 days in any 12 consecutive months.

Taxation in the UK primarily depends on a person’s residence status. Since April 2013 residence has been determined under the statutory residence test (SRT) explained in brochure RDR3. (click here) The SRT establishes residence status according to the number of days that an individual spends in the UK during the tax year that runs between 6 April and 5 April of the following calendar year. Residents generally pay tax on their worldwide income and gains whilst non-residents are generally only taxed on income from sources in the UK. However, individuals resident but not domiciled in the UK can elect to be taxed on the remittance basis where non-UK income and gains are only liable to tax when brought into the UK.

On its own, an individual’s immigration status has no bearing on tax liability. The investor should be treated as a regular non-domiciled taxpayer who requires the usual pre- and post-arrival tax planning measures. These are well publicised and may involve avoiding individual UK tax residence. Otherwise, prior to becoming UK tax resident, the investor should maximise the amount of clean capital and separate this account from foreign income and chargeable gains by creating separate bank accounts and thereby avoid remittances of anything other than clean capital once becoming UK tax resident. There are also more complicated arrangements that involve trusts and foreign banks. However, these measures should be taken with consideration of certain obligations that pertain to the granting of the Tier 1 (Investor) status.

Firstly, most investors seek to satisfy the requirements for the issuance of the ILR. In doing so they must spend at least 185 days in every 12-month period in the UK starting from the day of arrival in the UK under the newly issued leave to enter. This immediately denies the benefit of most UK-residence planning techniques based on the extended periods of UK non-residence. As a result, most tax planning measures should be undertaken before the investor’s arrival in the UK during stage one as explained below.

Secondly, the Immigration Rules require the investors to physically bring the investment funds in the UK. Unless these are derived from clean capital, accumulated during the period of non-residence, the investor will suffer the consequences of making a remittance of foreign income or gains, which will be taxed at the appropriate rate. Further remittances might occur where the investor pays for the services rendered by him or her in the UK, such as immigration advisors’ and solicitors’ fees. In the first case the recently introduced business investment relief might offer a solution as described below; however, the expense of planning for the minimisation of tax burden might nullify the tax benefits it aims to achieve.

It is possible to split the Tier 1 (Investor) immigration process in three stages. Stage one is preparatory during which the migrant collects the documents and submits the visa application. As stage two the investor arrives in the UK after receiving leave to enter the country. Stage three involves the migrant making the investment, which will permit the migrant to remain in the UK and to apply for the extension of stay until the he or she can apply for the ILR. There is usually a period of several months between stages one and two during which the investor stays in the home country waiting for the outcome of the application. The migrant has up to 90 days from arrival to fulfil the requirements of stage three. The investor should plan to remain non-UK resident during stage one and even partly through stage two; and during this period of non-residence should aim to perform the larger share of his or her tax planning strategy.

During stage one the applicant prepares and submits documentary evidence of the ability to invest at least £1 million in the British economy. This amount can be in cash or in readily convertible assets, such as bonds, shares, investments in companies or trusts. While the Home Office only requires proof of funds, it might be better to convert the assets to cash immediately without waiting for stage three. The rules prohibit the use of assets such as property as evidence of funds. The investor with funds locked up in capital assets will have no choice but to realise the assets in order to amass the necessary amount.

By disposing of the assets the investor will create clean capital that will not be liable to UK tax on future remittance. However, the investor might be liable to pay income tax in the country where the assets are situated or where he or she is resident. The rules allow the investor to rely on money that is owned either jointly with or solely by a close relative (spouse or partner). If the close relative is a lower rate taxpayer then, subject to the rules of their residence jurisdiction, the investor can gift the assets to the relative, which she or he can dispose of subject to the payment of a smaller amount of tax.

The money may be held overseas at the time of application or it may already be in the UK. However, the Home Office will only count investments that have been made in the UK in the 12 months immediately before the date of the application. The investor will have to make “fresh” investments, which might trigger tax consequences in the UK or in the residence state if to do so he or she must realise locked in capital.

As an alternative to realising the assets to make the investments, the investor can borrow £1 million from a UK bank provided that he or she can demonstrate the availability of net personal assets whose value exceeds £2 million. Provided that the loan is secured on clean capital assets, such as cash, real estate or shares, there should be no UK tax consequences on its receipt. However, there can be an issue if the investor uses their foreign income or gains to pay the loan interest. Because the loan is connected with the UK, any such payment will constitute a remittance liable to UK tax. If possible, the loan agreement should stipulate that interest is chargeable at the end of the loan period when the investor might become non-UK resident. Alternatively, the investor should use UK-source income, which has already been taxed to pay the interest.

Provided the requirements of stage one are satisfied, the investor will receive leave to enter the UK as a Tier 1 (Investor). The arrival in the UK should be timed with regard to the residence planning considerations as discussed next. At the same time the investor should not delay arrival in order to satisfy the continuous residence requirement required to apply for the ILR at the end of his or her stay.

The 12-month continuous residence period does not have to coincide with the UK tax year and can fall across two consecutive tax years. Under the SRT’s automatic UK test, the individual will become UK tax resident if he or she spends 183 days or more in its territory in a tax year. Therefore, if the investor arrives in the UK say on 1 February 2013 he or she will not be automatically UK resident during the tax year 2013/2014. Instead, the investor will use the sufficient ties test. The test envisages a number of the so-called “UK ties” that determine the proximity of a person’s connections with the UK. The more UK ties he or she has — the less number of days that can be spent in the UK during the tax year without becoming a UK tax resident. According to RDR3 (see the reference above) the investor will probably have only two UK ties in the first year in the UK: family and accommodation, which allows him or her to stay in the UK during the tax year 2013/2014 for up to 90 days without assuming residence here. If, however, the investor becomes resident under either of these tests, they might be able to apply split-year treatment and begin the UK residence period only from the date of arrival.

Additional planning opportunities might be offered by the tie-breaker clause in the residence article of the double taxation treaty that the UK might have with investor’s residence State, although complications might arise stemming from the mismatch between the tax years’ periods. HMRC provides an interesting explanation of this rule in part INTM154040 of its International Manual. (click here)

Under stage three the investor must invest £1 million in the UK. At least £750,000 of this amount should be invested by way of UK Government bonds, share capital or loan capital in active and trading companies that are registered in the UK. This amount should be maintained and replenished if market fluctuations cause the value of the investments to decrease. The rest of the sum can be invested in the UK, held on deposit or used to fund the purchase of a property in the UK.

Provided that the investment comprises clean capital accumulated during stage one, there will be no UK tax consequences on bringing the funds in the UK. In the opposite scenario, where the investments consist of foreign untaxed income and gains made after the date of first becoming UK tax resident, these will constitute remittances, on which the investor will be taxed at the applicable income tax rate. HMRC explain the meaning of remittance in part RDRM33140 of its Residence, Domicile and Remittance Basis Manual. (click here)

Most investors with clean capital choose investments in UK Government bonds preferring security to higher returns. However, at the 45 per cent maximum rate on the remitted untaxed income and gains the tax liability might be significant and there are ways of making the investments in UK companies without suffering tax consequences. More particularly, there is the business investment relief that was introduced in 2012. The relief allows the non-domiciled investor to invest foreign income and gains in UK companies through loan or share capital. The invested amounts are not treated as remittances and not liable to UK tax. However, there is a host of exemptions and limitations, which might deter some investors. Alternatively, the investor might receive income from his or her spouse who is resident outside the UK and earns income not liable to UK tax. The funds received from the spouse will constitute a gift, which is not liable to tax in the hands of either person.

There are high net worth individuals who choose the Tier 1 (Investor) route and find themselves in a situation where in the absence of UK credit history, banks refuse to lend despite the availability of significant assets worldwide. The investors might have cash and freely convertible assets but only just enough to make the qualifying investment in the UK; the rest being locked in various capital assets. To fund their living expenses in the UK such individuals might have no choice but to realise these assets and pay UK tax on the remitted income and gains. It is always preferable, however, for investors to take a medium to long-term planning strategy in respect of their immigration status, creating clean capital at the earliest opportunity before becoming UK tax resident and thereby minimising their future UK tax liabilities.